Because the level of a company’s stock price is arbitrary—it can be manipulated, for example, by firms via adjustments in the number of shares outstanding—if markets were fully efficient, nominal stock prices should be randomly chosen by firms. However, until just recently, the average nominal price of U.S. stocks had remained around $30 over the last several decades.

Why has this been the case? The academic literature provides the answer: Firms are well aware that individual investors are influenced by nominal prices. This leads them to adopt a higher allocation to lower-priced stocks than institutions.

The preference for low-priced stocks is illustrated through findings that individual investors increase their holdings after a split to lower a stock’s price level. Academic research has sought to provide explanations for this anomalous behavior (meaning that it’s irrational from an economic perspective).

One explanation is that individuals are looking for a cheap bet, as with lottery tickets. Therefore, they find lower-priced stocks attractive. Another is that investors might perceive low-priced stocks as being closer to zero and farther away from infinity. They thus have more upside potential and less to lose (of course, no matter how low the price is, you can always lose 100% of the investment). Both of these explanations are supported by research.

Price MattersVijay Singal and Jitendra Tayal, authors of the July 2015 paper “Nominal Stock Prices Matter,” contribute to the literature on the nominal price effect by segregating the size (a small company could have a low stock price, but that isn’t necessarily the case because it could also have a small number of shares outstanding) and price effects, then examining the relationship between nominal prices and returns by explicitly controlling for size.

To ensure their results were not driven by small, economically insignificant firms, they formed portfolios by choosing the largest 3,000 companies using Center for Research in Security Prices data from December 1962 to December 2013. These firms were then categorized into size deciles, followed by price deciles within each of the size deciles. Following is a summary of the authors’ findings:

The highest price group earns 0.45% more than the lowest price group over a 12-month period.

However, because low-priced stocks generally outperform high-priced stocks in January, the outperformance of high-price stocks is economically much larger at 5.79% over an 11-month period excluding January.

Outperformance is also larger when four-factor (beta, size, value and momentum) abnormal returns are considered. In this case, the outperformance is a statistically and economically significant 4.32% per year and 6.22% for the 11 months excluding January.

High-priced stocks statistically and economically significantly outperform low-priced stocks in 38 of 51 years. On the other hand, low-priced stocks significantly outperform high-priced stocks in only six years.

Comparing returns two, three and four years before a stock split with returns two years after the split, they found presplit returns are consistently greater than postsplit returns by 31.60%, 23.33% and 15.49%, depending on the comparison periods. The return differences are largely unaffected when controlled for the market. The result implies that returns fall after a stock split concurrent with a decrease in price.

As a check on robustness, the results were not driven by extremely low-priced stocks. And the return differential, although smaller in magnitude, is robust to momentum specification. Additionally, the outperformance of high-priced stocks over low-priced stocks remains significant after controlling for variations in idiosyncratic volatility.

The higher idiosyncratic volatility and higher idiosyncratic skewness of low-priced stocks are associated with lower returns.

That high-sentiment high-priced stocks strongly outperform high-sentiment low-priced stocks indicates sentiment plays a significant role in driving returns, and that investors are more likely to bid up the values of low-priced stocks. This result holds with and without January; the return differential is 13.14% for the full year and 16.88% when January is excluded.

Retail Investors Face ExploitationIt appears that while institutions are well aware of the poor results, individual investors are not. Singal and Tayal found that the number of individual shareholders is consistently higher for low-priced stocks across all their size deciles when compared with the number of individual shareholders holding high-priced stocks.

On the other hand, the authors found more institutions invest in high-priced stocks across all size deciles. This is another example of retail investors being “dumb money” that can be exploited by more sophisticated investors.

In summary, the research presents strong evidence on the pricing anomaly that low-priced stocks, especially those with high betas, high idiosyncratic volatility and high skewness, are overweighted by individual investors due to the preference for lotterylike bets and because they incorrectly perceive low-priced stocks as having more upside potential and less downside risk.

On an interesting and related note, firms that rely on the evidence from academic research when designing their portfolio constructions rules (such as Bridgeway and Dimensional Fund Advisors) have long screened out low-priced stocks. (Full disclosure: My firm, Buckingham, recommends Bridgeway and Dimensional funds in constructing client portfolios.)

Larry Swedroe is the director of research forThe BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.